Posts Tagged ‘Keynes’

This one is almost too easy. Krugman charges freshwater macroeconomists with epistemic closure. He writes,

Ask a grad student at Princeton or MIT, “How would a new classical macro guy answer this?”, and the student can do it; classes at freshwater departments teach real business cycle theory, and good students can tell you what it says even if their professors have a different view.

But students at freshwater schools — or, alas, many of their professors — can’t return the favor. It’s been painfully obvious since the crisis broke that people at Minnesota, or even many people at Chicago, have no idea what New Keynesian economics is all about. I don’t mean they disagree, or think it’s garbage, they literally have no idea what the concepts are. And that’s why they reinvent 80-year-old fallacies when they try to discuss the subject.

It’s interesting to ask why this sort of cocooning is a feature of the right but not the left. But it’s very real, and has a dire impact on economic as well as political discourse.

Of course, we can just as easily replace salt-water students in this analogy with students of heterodox economics/political economy, and freshwater economics with the whole mainstream. For instance, ask a post-Keynesian or a Marxian to hold court on IS/LM, and they can do it easily. This is not because these economists are heroic; instead, they realize that is essential to build a counter-theory by learning the original theory and its critique.

My course in Marxian political economy began with a reschooling in intermediate micro and macro- we actually learned this stuff better a second time by being forced to think critically about it. However, ask Krugman or his friends at Princeton and MIT about the starting point for Marx’s critique (hint: use-value versus exchange value) or Polanyi’s (hint: embeddedness) and I fear their eyes might glaze over. If the mainstream response to my argument is that the aforementioned critiques are not “serious economics,” well, we no longer have anything to talk about.

P.S. (private message for David Ruccio)- since I’ve dispensed with this one easily enough, hopefully you can take some time to follow up on my post re: Sen/Smith.

I was given a manuscript by Oxford University Press, the publisher of Roger Farmer’sHow the Economy Works, which was released yesterday. My review, which in the interest of disclosure was of my own volition, is below. Also in the interest of disclosure, I’ve been offered a published copy of the book, but this was not in exchange for a review, positive or otherwise.

Don’t let the ambitious title fool you; Roger Farmer’s new book, How the Economy Works, is actually a targeted policy proposal embedded in an attempted synthesis of Keynesian and new-classical economics. Coming on the heels of the crisis, it might more aptly be called How to Make the Economy Not Not Work. Walking the tightrope between Keynesian and classical, Farmer manages to deal fairly with the basics of each approach. Thus, the first part of the book, which focuses on history of economic thought, exists mainly in the rather limited universe of the mainstream. However, Farmer seeks to do more than just summarize, seeking a “new approach” to go forward from this “third turning point,” the first two being the Depression and the Keynesian collapse in the 70s.

What does he take from the preexisting paradigms? He accepts the basic concept of using classical microfoundations based on rational decisions to scale up to the macroeconomy. From Keynesian economics, he accepts the idea of market failure; as for behavioral economics, which models the “failure” of individual decision-making, Farmer does bother. The methodological underpinnings common to both mainstream approaches remain, as Farmer fundamentally believes in equilibrium analysis as a sound way of probing the economy. Farmer’s primary innovation stems from the principle that demand is determined not by income but by wealth, which along with other fundamentals is determined by confidence. This move is important because it discredits the viability of fiscal policy in a recession.

Don’t think that Farmer is just a standard monetarist, though- he actual promotes a pretty radical idea for stabilizing the economy in rough times. He argues that given the issues with the zero interest rate bound of monetary policy, the Federal Reserve and other central banks should actually target a stock market index. They would do so by creating an index fund, and as part of their policy announcements, prescribe a price path for this fund, whereby they will guarantee the repurchase of shares in this fund at the set prices. The idea is to make stocks a lower-return, lower-risk venture so that it is always safe to invest in them, and thus to facilitate reallocation of funds among succeeding and failing enterprises. This asset price stabilization would ensure confidence and thus employment-generating wealth creation.

Given his proposal, it’s striking that Farmer actually ends the book in a discussion of Hayek. Farmer’s proposal involves such deep intervention in the economy that it would cause Hayek to roll in his grave. Government provision of a price path for stocks is not so different from a price path for wages or for specific commodities. While he claims the middle ground with classical economics by emphasizing the market nature of the actual price determination process. his ideas seem far more Keynesian than classical.

There are many places he doesn’t go in this book. He discusses demand at length and of course refers to fundamentals, arguing that confidence should be considered a fundamental in its determination. Straddling the mainstream Keynesian-classical nexus, Farmer offers no discussion of the distributional roots of demand. Because wealth is a key link in his argument, Farmer attributes the current crisis as a collapse in demand due to a collapse in wealth. However, it’s unclear if restored confidence can square the circle, as many now argue that the wealth was fictitious in the first place. Without the anesthetic of the housing bubble, it’s arguable that our economy would not have supported low unemployment rates through 2006, but instead would have been generally stagnant as the country followed a low growth path.

What then? If we resign ourselves to modest stock price growth, proxying modest economic growth, then we’ll realize that things aren’t as good as they could be, and even in its “steady state,” the economy simply isn’t working. Don’t get me wrong- this would be a huge advance; real economic transformation will only arise when we realize that the steady state of our economy does not offer the job creation we desire or the wealth distribution that many seek. What will it look like? How will we get there? Farmer simply doesn’t go there, and these questions are firmly in the book’s blind spot. The money question- will it work?- remains in doubt.

Nevertheless, I think Farmer’s regulatory proposal has a lot to offer. While financial swings may not be the root cause of the crisis, they have certainly exacerbated it. Allowing the Fed to take a more active role in the path price of the stock market would remove a lot of uncertainty from the economy. It’s certainly dubious that the Fed would ever accept this sort of power- remember that we are only a few years removed from a chairman who was a disciple of Rand and Hayek. Along the same lines, this book is quite useful- it’s a good crash course in the mainstream of economics, and it ends with a bang. One would hope that the discerning reader will not simply leave the details of the economy’s other fundamentals (beyond confidence) to the classicals and new-classicals, as Farmer does.

Farmer demonstrates that thinking outside the box within the mainstream does not have to be constituted solely by behavioral economics or large rstimulus packages, but I would still cautiously consider the book a missed opportunity. Clearly, Farmer has done enough to anger colleagues on both sides of the spectrum (although his obvious personal affection for folks such as Lucas, Prescott, et al. will pardon him from exile). Given that he is willing to do something unique within the existing paradigm, why stop there? Why are mainstream economists unwilling to view distribution as an endogenous determinant of demand? A truly radical rethinking, I would argue, must go there. Farmer doesn’t, but I think his effort can at least push the mainstream a little bit in the right direction.

A while back, I posted a Newshour clip about the making of a Keynes/Hayek rap video. The full video has been released, and it is awesome- high production value and high comedy. Keynes’ biographer Lord Skidelsky says of it, “Absolutely fair and brilliantly rhymed…It’s not a complete account of Keynes but it seems to be completely right.”

Via Crooked Timber (h/t Thoma), James Galbraith has an article (pdf) for the NEA Higher Education Journal in which he takes on mainstream economics as a whole. First, he points to a quote from Krugman’s much cited NYT Mag piece from September:

Of course, there were exceptions to these trends: a few economists challenged the assumption ofrational behavior, questioned the belief that financial markets can be trusted and pointed to the longhistory of financial crises that had devastating economic consequences. But they were swimmingagainst the tide, unable to make much headway against a pervasive and, in retrospect, foolishcomplacency.

To which Galbraith responds:

And yet, there is something odd about the role of this short paragraph in an essay of over 6,500 words. It’s a throwaway. It leads nowhere. Apart from one other half-sentence, and three passing mentions of one person, it’s the only discussion—the one mention in the entire essay—of those economists who got it right. They are not named. Their work is not cited. Their story remains untold. Despite having been right on the greatest economic question of a generation—they are unpersons in the tale…

Krugman’s entire essay is about two groups, both deeply entrenched at (what they believe to be) the top of academic economics. Both are deeply preoccupied with their status and with a struggle for influence and for academic power and prestige—against the other group. Krugman calls them “saltwater” and “freshwater” economists; they tend to call themselves “new classicals” and the “new Keynesians”—although one is not classical and the other is not Keynesian…

The two groups share a common perspective, a preference for thinking along similar lines. Krugman describes this well, as a “desire for an all-encompassing, intellectually elegant approach that also gave economists a chance to show off their mathematical prowess.” Exactly so.

So why did economics fail to get it right?

The reason is not that there has been no recent work into the nature and causes of financial collapse. Such work exists. But the lines of discourse that take up these questions have been marginalized, shunted to the sidelines within academic economics. Articles that discuss these problems are relegated to secondary journals, even to newsletters and blog posts. The scholars who betray their skepticism by taking an interest in them are discouraged from academic life—or if they remain, they are sent out into the vast diaspora of lesser state universities and liberal arts colleges. There, they can be safely ignored.

Galbraith then takes a brief survey of the “nether wastes” of economics. I won’t summarize this whole section, but here’s what he says about the Marxians, whom Galbraith terms “habitual Cassandras”:

For this tradition, class struggle and power relations generally remain at the heart of economic analysis, and crisis is inevitable—sometime…The radicals also lack interest in policy: at the heart of things, they do not believe the existing system can be made to work.

Galbraith also looks at “bubble detectors,” post-Keynesians, and even economic “criminologists.”

His conclusion is firm and striking:

This work is significant in ways in which the entire corpus of mainstream economics—including recent fashions like the new “behavioral economics”—simply is not. But where is it inside the economics profession? Essentially, nowhere. It is therefore pointless to continue with conversations centered on the conventional economics. The urgent need is instead to expand the academic space and the public visibility of ongoing work that is of actual value when faced with the many deep problems of economic life in our time. It is to make possible careers in those areas, and for people with those perspectives, that have been proven worthy by events. This is—obviously—not a matter to be entrusted to the economics departments themselves. It is an imperative, instead, for university administrators, for funding agencies, for foundations, and for students and perhaps their parents.

Reading this article makes me even sadder about the missed opportunity for Notre Dame’s economics department to make itself truly cutting edge.

American Spectator (h/t Thoma) has an interview with Robert Skidlesky, author of Keynes: The Return of the Master. One passage sticks out:

JL: In closing your narrative, you make the unusual proposal that students of economics should be required to master different and complementary fields, such as history or political science, when pursuing economics doctorates. But so far economics departments seem entirely unrepentant in their ways, despite the recent failures of their profession. Do you see your suggestion gaining traction in any schools or with any other economic thinkers?

RS: I don’t think that we can expect this kind of structural change to occur quickly. Remember that only a bit more than a year ago most people still did not see the end of the boom. Commodity prices had peaked and there was definitely a sense of anxiety amongst those who followed the movements of asset prices but the night before Lehman collapsed most economists were sleeping blissfully ignorant. It was not until the 24th of October — roughly six weeks later — that Alan Greenspan admitted to a “flaw” in the “intellectual edifice” and that the economic crisis became accepted as a crisis for economics. There has only been one academic year in between then and now. Universities move slowly. We have yet to see the full impact of the current crisis on the way economics is done. But there are many straws in the wind. Even if my specific suggestions are not acted on, there is agreement among many economists that economics is over-burdened with maths, and that realism is sacrificed for the sake of mathematical tractability. In his review of my new book, Paul Krugman supported the general idea of restructuring economics although he might have thought my actual proposal too extreme. However, I maintain that the seemingly extreme attraction of false perfection offered by microeconomic mathematisation requires “extreme” countermeasures.

If only. As early as Fall of 2007, concerned students at Notre Dame were pushing the idea of having a required course in history of economic thought or political economy. This was immediatly after the addition of econometrics as a required course. The proposal, and open letter and petition that followed, fell on deaf ears. And now, we are where we are.

The other thing to keep in mind about undergraduate economics curricula is that we are not learning the fancy math behind micro and macro. We are learning stylized versions of it. To say that history of economic thought is any more rigorous than introductory micro is intellectually dishonest. Of course, the best teachers of introductory micro (at least at ND) manage to weave this history into their lectures in any event. Sadly, they are all in the department that is being shuttered.

Michael Perelman, who blogs at EconoSpeak, has posted an essay (pdf) called “An Idiosyncratic Road to Crisis Theory” (actually, he posted it last sunday, and I’ve been too lazy to blog about it). He manages to cover a lot of ground in ten pages, particularl with regards to capital theory. His introduction may be the most provoking part, however:

As an undergraduate, introductory microeconomics didn’t make any sense. After a few weeks, I realized that it was easy to get a good grade until by working backwards. Since the goal was to show that everything worked out perfectly, all you have to do on an exam is to start with the answer that the market creates the best outcome, then work backward to figure out what would make it occur. Economics soon became my easiest class. Although I do not follow that procedure anymore, I am convinced that much of the economics profession still does. Eventually, some seemingly obvious questions began to trouble me.

Economics, which purports to explain the nature of a capitalist system motivated by profit maximization, lacks a theory of capital as well as any coherent explanation of the determination profits. One of reasons is simple: economics generally deals with a static conception of the world, yet fixed capital, which becomes increasingly important with the maturation of capitalism, calls out for a dynamic analysis, even with a static conception of the world.

Robert Skidlesky has an opinion piece in the Financial Times (h/t Mark Thoma) in which he injects the insight of Keynes and the notion of intellectual battles into current debates. Skidelsky is an important scholar of Keynes, and wrote an award-winning three-volume biography about his life and work.

Skidlesky begins by distinguishing economics from the natural sciences:

In the social sciences, the situation is different. There have been famous battles galore, but no decisive victories. Indeed, it is characteristic of the social sciences that their battles are interminable, temporary defeats being followed by the regrouping of the defeated forces for a renewed assault.That economics is not a natural science is clear from the inconclusive engagements that have punctuated its own history.

A hundred years ago the classical theory reigned supreme…

Then along came the Great Depression of 1929-32 and John Maynard Keynes. Keynes “proved” that markets had no automatic tendency to full employment…

For 30 years or so Keynesianism ruled the roost of economics – and economic policy. Harvard was queen, Chicago was nowhere. But Chicago was merely licking its wounds. In the 1960s it counter-attacked. The new assault was led by Milton Friedman and followed up by a galaxy of clever young disciples…

No policymaker understood the maths, but they got the message: markets were good, governments bad.

He then contextualizes a current debate, between Niall Ferguson and Paul Krugman, in these intellectual battles. While ultimately siding with Krugman, I think he makes an extremely important point:

In this particular debate, I am on Prof Krugman’s side, but I do not agree that Prof Ferguson’s position represents a retreat to a phlogiston state of economics. This is to take economics to be like a natural science, which Keynes never believed it was, because he thought its subject matter was much too variable over time.Keynes’s view was that we need different economic models at different times. The beauty of his General Theory of Employment, Interest and Money was that it was general enough to accommodate a variety of models applicable to different conditions. Markets could behave in ways described by the classical and New Classical theories, but they need not. So it was important to take precautions against bad behaviour. Ultimately, the Keynesian revolution was a triumph not of good science over bad science, but of good judgment over bad judgment.

Judgment is something often overlooked as extremely important in economics and in finance. This morning, I listened to the This American Life podcast from last week, which looked at the regulatory failures leading up to the current crisis from both the government and rating agency points of view. When talking with people from the ratings agencies in particular, it was clear that there was an utter refusal to exercise judgment. The equations were the equations. So what if the data might seem logically unapplicable? The future will reflect the past, etc.

So, the question of the day is, given all we now know about the causes of this economic crisis, what sort of judgment will be applied, both in academia and in the policy world? What factors will people in power choose to ignore? Sadly, I think the wage-stagnation/class-based argument, which has been well-outlined by Richard Wolff, will probably be ignored.

Is there a new Keynes for this generation, who will restore “good judgment” to the dominant economic paradigm? Perhaps Keynes will be the new Keynes. I think these are important open questions as the discipline’s introspection continues.

Open Economics

This blog is administered by a group of students and alumni from the University of Notre Dame who are interested in engaging and debating the world of economic phenomena we face, everywhere and everyday.
Disclaimer: Opinions expressed herein are the authors' own and not those of any organizations or employers to which they are attached.